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In what ways can fiscal policy affect aggregate supply?

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armyof32000 | (Level 1) Salutatorian

Posted July 25, 2013 at 9:43 PM via web

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In what ways can fiscal policy affect aggregate supply?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted July 26, 2013 at 1:36 AM (Answer #1)

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We usually say that fiscal policy has more of an impact on aggregate demand (AD) than on aggregate supply (AS).  However, it is possible for fiscal policy to affect AS.  This can happen through tax policy or through government spending.

It is possible for government spending to affect AS.  This happens only if the government spends money on investments.  For example, if the government spends money on research into clean energy, it might eventually increase AS by increasing our clean infrastructure.

However, we would be more likely to argue that taxation can affect AS.  This is why supply side economists argue that we should lower taxes.  Supply siders argue that a decrease in taxes will lead to an increase in such things as investment and work.  They argue that people will be more likely to work more hours and more likely to invest if they are able to keep more of the money that they make.  Thus, a decrease in taxes should lead to an increase in the amount of work and investment being done.  This will lead to an increase in AS.

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